Moody's Investors Service today said India's future sovereign credit profile is more exposed to negative effect of drought, but the steps taken by the government, if sustained over the next 2-3 years, could have a mitigating influence.

"Although India may avoid drought this year, its economy remains vulnerable to future drought or fluctuations in rainfall, and its sovereign credit profile is more exposed to the negative effect of drought than those of most 'Baa' rated sovereigns," Moody's said in a report.

It currently rates India at 'Baa3', the lowest investment grade -- just a notch above 'junk' status.

In its report titled 'Vulnerability to Drought Poses Credit Challenges', it said the efforts at the central and state government level to improve rural infrastructure, food distribution and non-agricultural employment opportunities are credit positive because, if sustained, they are likely to lower the credit challenge that India's vulnerability to drought poses.

"If these government efforts are sustained and successful over the next 2-3 years, they could lower India's vulnerability to drought. They would also benefit India's overall sovereign credit profile because they would lead to higher incomes, stable and lower inflation, and a lower fiscal burden related to food subsidies," it said.

The report compares India with several other countries in which agriculture has a major share of GDP and concludes that Indian economy's vulnerability to drought stems from a combination of factors like a relatively high share of agriculture in overall employment and weak rural infrastructure and irrigation.

Besides, "inefficient food distribution, a large proportion of Indian household spending on food and share of food subsidy costs in the government's fiscal deficit makes India more vulnerable to drought", Moody's noted.

"Because of the above characteristics, drought can simultaneously lower GDP growth, raise inflation and add to fiscal pressure, leaving India's sovereign credit profile more susceptible to the effect of drought compared with those of other Baa-rated sovereigns," it said.

India's economic exposure to annual fluctuations in rainfall constrains the ability of the monetary policy to respond to ongoing macro-economic developments. This is particularly so in years such as the current one when a weak monsoon forecast coincides with an uncertain cyclical recovery, Moody's added.

The report said India's vulnerability to drought could decline over the longer term as average incomes rise.

"But in the near to medium term, policies to improve infrastructure, food distribution, and non-agricultural employment opportunities hold the key to reducing the annual economic uncertainty that is linked to the performance of monsoon," it stated.